Construction owners should beware. The current economic downturn has been rough on the construction industry. Contractors who enjoyed the robust growth of the last several years may suddenly be struggling financially.

To offset the loss of revenue, some contactors may be cutting costs in ways that will directly affect their ongoing construction projects -- laying off workers, selling equipment, and, in extreme cases, cutting corners on current projects.

The residential and private commercial construction markets have evaporated. Revenue-starved contractors are shifting their focus to public construction projects. The Dayton Business Journal recently reported that 19 construction companies -- more than double the usual amount – submitted bids for a school project in Dayton, Ohio.

This migration into the public market should concern public owners. These contractors may not have the experience or the financial wherewithal to properly complete a public project.

This article will provide a brief overview of some contract provisions that may help owners in the current economic market.

Selecting Qualified Contractors

Many owners do not think of bidder criteria when they plan their construction project. However, for public owners in Ohio, if specific criteria for evaluating bidders are not included in the bid documents provided to bidders, the owner cannot exercise the broad discretion granted by public bidding laws.

A public owner can award a contract to a bidder based upon factors that the owner determines to be important, so long as the factors are rational and included in the bid documents published and provided to bidders.

In this economic environment, instead of evaluating bidders based solely upon the bid amount, an owner may choose to look more closely at other qualifications, like the contractor’s financial condition, the contractor’s prior performance on similar projects, the contractor’s history of submitting claims, the past performance of the contractor’s surety, and the adequacy, in numbers and experience, of the contractor’s work force. These types of criteria are often included by public owners in their bid documents and used to evaluate bidders prior to award of contracts.

Bid documents that announce award criteria that take into account a bidder’s experience and financial condition will improve the owner’s chances of selecting a contractor that will remain financially stable in this recession.

Contractors must Provide Competent Workers

A contractor may try to offset its loss of revenue by employing cheap, unskilled labor to cut labor costs. If a contractor fails to employ competent contractors, the results for an owner can be catastrophic -- leaking roofs, HVAC systems that do not operate properly, and delay claims. These types of issues can cost millions of dollars to repair and cause years of headaches and political embarrassment.

Most contract documents require some level of competency for workers assigned to a project. Both the AIA and the EJCDC form general conditions documents include requirements that the contractor provide properly skilled workers.

The Contractor shall enforce strict discipline and good order among the Contractor’s employees and other persons carrying out the Work. The Contractor shall not permit employment of unfit persons or persons not properly skilled in tasks assigned to them. (AIA Document A201-2007, Section 3.4.2)

Contractor shall provide competent, suitably qualified personnel to survey and lay out the Work and perform construction as required by the Contract Documents. [EJCDC Document C-700, Section 6.02(A) Emphasis added.]

If a contractor fails to provide qualified workers under either of these documents, an owner may declare the contractor in default of its contractual obligations and seek all available remedies, including resorting to the contractor’s bonding company to properly complete the contract.

Notice of Claims Requirements

With the economy in a recession and little sign of relief in the near future, the number of construction claims is going to increase. For an owner, a properly drafted notice provision is critical to plan for and defend against claims. A notice provision should (1) require the contractor to provide prompt written notice of the claim; (2) require the contractor to provide the owner all the information needed to investigate and verify the claim; and (3) bar all claims that do not comply with the notice requirements.

Prompt notice allows an owner the opportunity to take prompt action on the claim. The owner can investigate, withhold payments from the responsible party, and control its discretionary spending.

The AIA General Conditions document establishes a 21-day time limit for initiating a claim in Section 15.1.2:

Claims by either the Owner or Contractor must be initiated by written notice to the other party and to the Initial Decision Maker with a copy sent to the Architect, if the Architect is not the Initial Decision Maker. Claims by either party must be initiated within 21 days after occurrence of the event giving rise to such Claim or within 21 days after the claimant first recognized the condition giving rise to the Claim, whichever is later.

The EJCDC General Conditions document establishes a different process for filing a claim on a project:

Written notice stating the general nature of each claim shall be delivered by the claimant to Engineer and the other party to the Contract promptly (but in no event later than 30 days) after the start of the event giving rise thereto.

If notice is provided after 30 days, the contractor will be precluded from bringing the claim.

An owner should review the contractual claims procedure in the construction contract to confirm that the contractor complied with the notice requirements before settling any claims.

Payment Procedures

An owner can use the payment procedures to protect itself from defective work on a project by withholding enough funds to make any required repairs. The construction contract should define the process and give the owner discretion to pay the contractor when there is a question about either the quality or stage of the work for which payment is requested.

The AIA General Conditions document limits the owner’s role in the payment process. If the architect certifies the contractor’s payment application, the owner’s role in the payment procedure is limited. Section 9.6.1 states:

After the Architect has issued a Certificate for Payment, the Owner shall make payment in the manner and within the time provided in the Contract Documents, and shall so notify the Architect. [Emphasis added.]

However, an architect has an obligation not to issue a Certificate for Payment if the architect is aware of defective work. As such, an owner should diligently monitor the work on the project and raise any concerns with a contractor’s performance with the contractor and architect in writing.

If the issue is significant, the owner may need to request that the architect not issue a Certificate for Payment until the issue is corrected or resolved. If the owner’s concerns are legitimate, the architect has a duty to comply with the owner’s request and not certify the contractor’s pay application.

The EJCDC General Conditions document allows the owner to withhold payment from a contractor, regardless of the engineer’s recommendation. Section 14.02.D.1 gives the Owner discretion to refuse payment if:

a. claims have been made against Owner on account of Contractor’s performance or furnishing of the Work;

b. Liens have been filed in connection with the Work, except where Contractor has delivered a specific bond satisfactory to Owner to secure the satisfaction and discharge of such liens;

c. there are other items entitling Owner to a set-off against the amount recommended; or

d. Owner has actual knowledge of the occurrence of [items related to defective Work.]

Surety Bonds

In these unprecedented economic times, owners should have a contingency plan ready in the event that a contractor closes up shop and cannot complete the project. Requiring a contract bond issued by a qualified surety is one step to help assure that a project will be completed if the contractor cannot do so.

Public owners in Ohio generally must require contract bonds for a construction contracts. Construction counsel can help an owner make a claim under the contractor’s bond. The form of contract bond is important. The Ohio Revised Code includes forms for both a combined bid guaranty and contract bond and a contract bond that covers both payment and performance of the contractor’s contractual obligations.

A surety is a company that assumes the obligations of the contractor to the owner under the construction contract through a bond written for the benefit of the owner. If the surety is obligated to perform, it can (1) pay the defaulting contractor to perform; (2) hire a replacement contractor; or (3) compensate the owner for the costs of completing the project. Sometimes, a surety may investigate the owner’s bond claim and determine that it is not obligated to perform.

Conclusion

The economic downturn has been trying on the construction industry, with no end in sight. Contractors who are not financially stable may not survive and may not be able to finish projects. An owner who understands the obligations and processes included in the Contract Documents will be better positioned to deal with these types of situations and still finish the project.